November 19

A comprehensive, well done overhaul of IA Regulations


A regulatory authority has the mandate to develop the industry as well as protect the welfare of the investors, who are the ultimate consumers.  When the IA Regulations came in 2013, it did not look like a water tight regulation.  It looked fairly indulgent in it’s approach, which may have been intentional, as it was the first step in the direction of ushering fee-only advisories.

There were many areas which were left somewhat ambiguous & other areas which allowed a bit of latitude.  The Consultation paper seeking to amend IA Regulation, is a step in the right direction. Most of the proposals are plugging the gaps in the previous iteration of the regulation.

Allowing a SIDD under a corporate entity has many problems. A proper segregation, cannot really happen within the same entity, irrespective of any chinese walls which one may erect!  Secondly, information sharing can happen between the advisory division & distribution department. This kind of information sharing happens in banks, all the time. Privileged information of the banking client is shared with impunity with the sales team, who use it to ensnare customers.  The same problems easily can happen in any financial services firm, which has different activities under it.

Thirdly, it violates the principles of justice, as a corporate entity is allowed to do both activities under one entity, but the individual adviser has to choose between advisory activity or distribution. A corporate entity can easily create a completely different entity.

This lacuna has been addressed by the consultation paper where it seeks corporates to create separate subsidiaries.

It is not directly addressing the unfettered information exchange with a subsidiary, but that is how it should be. Without the express consent of the client, no information should be passed on, even to a wholly owned subsidiary, in the interest of propriety. The transition time period of three years is excessive ( for corporates & for banks by RBI ), when a mere six months was given to transition when the IA Regulations were introduced.

The fee of Rs.5 Lakhs for corporates is excessive & has not been addressed, considering that many “corporates” are being formed by individuals.  Now, a subsidiary also would be needed. There is an urgent need to bring the fees back to Rs.1 Lakh or lower, to encourage corporatization of businesses.

It clarifies the ambiguity surrounding “consideration”  too. Even if an adviser does not charge fees and he or his subsidiary/ associates receives a commission or gets any economic benefit, it is still remuneration & will have to comply with IA regulation.  It is clear that any monetary arrangement will come under the ambit of IA Regulation.

They have not clarified what happens when an advisor truly advises pro bono.  In such a situation, the advice has the potential to affect the person advised, but if the advice is incorrect, the advised has no recourse at all, because he has not paid for it!  While one is under no compulsion to offer advice for free, the advisor needs to be held accountable for any advice given, paid or otherwise.

This consultation paper also seeks to sharpen the distinction between advisory & distribution.  So, a person / firm needs to decide whether they would like to distribute products or provide fee-only advice.

In this context, there is lot of sound & fury about whether the time has really come for fee-only advisory.

The changes that we see today are the result of excesses from the past.  Regulations have been closing in the world over, after the crippling financial frauds of 2008. It’s reverberations have been felt  globally.  The actions of the financial services firms can make or mar societies, even entire nations. That’s why regulators have been cracking the whip.  Inspite of all these, there are still scams happening. Wells Fargo misdemeanor is the latest.

Fiduciary is the new standard that regulators prefer. They want advisors to act in the best interests of clients, which is correct.  In US, they are looking at introducing Fiduciary standard on even Retirement product sellers. That’s why transparency & true advice is gaining currency the world over.

Earning a commission is not wrong; but regulators increasingly want consumers to access proper advice, before buying products. Seen in this light, it would make sense.  It’s time for financial advisors to change; to adapt to the new, emerging environment of advisory.  Done right, it will not only work well for everyone, it will be immensely satisfying as well.  Also, my personal experience is that people are willing to pay remunerative  fees , if they know they can implicitly trust their advisor & if the advisor offers true value.

The incidental advice was another aspect of IA Regulation that was being loosely interpreted.  Some interpreted that if the income from advisory was not significant, then the advisory practice itself is incidental. Some others felt that if they do not collect fees, then it can be termed incidental.  Some Professionals like CAs felt that any advice they offer along with their practice as a Chartered Accountant, was incidental. Now, the speculation surrounding incidental advice has been put to rest. Anyone who wants to provide advice needs to register with SEBI.

SEBI also wants to curtail the loose use of the term Independent Financial Advisor / Wealth Advisor, by distributors.  Those wanting to use such appellation now need to register. Those wanting to continue distributing products would need to use the term Mutual Fund Distributor.

There is again consternation about the fact that the Distributor would still have to provide a certain level of advice, but is not allowed to do so, as a Mutual Fund Distributor.  My understanding is that the distributor can do need-satisfaction selling. He could match client needs with the appropriate product benefits, which in their case would be satisfactory discharge of duty.

An advisor on the other hand would need to understand the needs, goals and their timing, analyse the client’s situation, look at their risk bearing ability, examine alternative strategies  and finally come up with appropriate asset allocation & specific product options.  These two are entirely different.

There was also uncertainty surrounding automated advice, also called Robo Advisory.  The consultation paper specifies that any automation including Robo Advisory is fine to use in an advisory practice. It also recognizes the potential for Robo advisory to deliver advice in a cost effective manner.

Robo advisories or any hybrid models providing advice, need to be compliant of IA Regulations. The paper also specifies various controls for such automated tools used for advice or leading to advice – such tools need to be fit & suitable for the intended client set, proper disclosure on how the tool works & comprehensive system audits need to be complied with.  It also clearly specifies the importance of validating the integrity & fidelity of the output delivered vs what they should be delivering.

SEBI has been wanting to ensure that the. Feeonly advisory catches up among the public in their best interests.  To help the advisors and incentivise the clients to seriously consider coming to an advisor, thee the client pays to a RIAshould be tax deductible. In other countries where RIAs are present, such an incentive is being given. This would go a long way in pushing the advisory profession in the right direction.

This iteration offers many other clarifications & directives which make for a much more robust IA regulation. The direction is now clear. Focus on Advisory, fiduciary standard, proper segregation of functions & lowering the cost to the clients have been given a pride of place in these regulations. The loopholes which were sought to be exploited have been largely plugged.

The regulation had been abused in the past.  Many wanted the respect of being a RIA, but wanted to continue their distribution business.  Others wanted to be distributors but wanted to offer “incidental” advice, without complying with the regulations.  Both these have become much more difficult now.  One needs to define what business one is doing – distribution or advisory. This clarity is actually a good thing for everyone – the customers, distributors  & advisors.


IA regulations, Registered investment advisers, suresh sadagopan

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